Skip to main content

Don’t rush to prepay your housing loan


   RECENTLY, I met a very savvy businesswoman who had just received a windfall and she was in a tearing hurry to prepay her loan taken at a very attractive rate of interest. Her income is extremely high and EMIs were comfortable and technically there was no rush to prepay the loan. However, there was an emotional urge to pay off the loan. When I inquired further, I realised that she might require some funds in the next 18 months. I told her that she had already paid a lot of interest in the first two years and considering her financial need, she should really think whether it makes sense to prepay the loan.


   She didn't have a clear answer to it. I went on to demonstrate how her loan repayment is scheduled.


   The interest paid per year is 5.36 lakh. That means at flat rate of interest it works out to be 5.36%. This is excluding the tax benefits that she would have received on the interest payments. In her case, the entire interest can be claimed as expense. This translates into a savings of 53.63 lakh * 0.309 (tax rate) = 16.57 lakh. Hence, the actual interest payout post tax benefits will be 53.63 lakh – 16.57 lakh = 37.06 lakh. This means that 3.7 lakh will be the interest paid per year on a 1-crore loan and hence, the interest rate paid per year works out to be 3.7%. If she is able to pay more than 3.7% on this loan she should retain the loan.


   Now, if one invests 1 crore for a period of 10 years, the number will speak for itself. 1 crore invested for 10 years at a compounded rate of even 6% will be 1.79 crore, which is 26 lakh more than the total payouts she would have made (without factoring any tax benefits). On a 8% return, the corpus jumps to 2.15 crore, which is 62 lakh more than the loan payout, whereas on a 10% return the corpus will be 2.5 crore, which is 1 crore more than the loan payout.


   There were two key mistakes the lady had committed and I have seen many learned people making the same mistake.
   

Case 1:

Looking at this loan in isolation without understanding it's impact on overall financial requirements.


   The lady made a very basic calculation and decided to pay it off. However, she forgot to take stock of her fund requirements in the coming months. She wanted to buy a piece of equipment for which she would have to borrow at 13%. A loan with an interest rate of 9.25% is a very attractive rate of interest, considering that rates of interest have gone up in recent times. For most people who have home loans, keep this in mind that a home loan is the cheapest form of loan and if you have secured it at a low rate of interest it does not make any sense to pay it off especially if you have any liquidity needs in the near future.

Case 2:

Not understanding the compounded returns needed to justify the loan.


   Most people do not calculate the compounded returns required to justify a loan. They also forget to add the tax benefits that a business or home loan can provide and sometimes do not accurately calculate the returns they need to earn to keep the loan. As seen in the example above, even a compounded return of 6% justifies keeping the loan of 9.25%.

 


Popular posts from this blog

ULIP Review: ProGrowth Super II

  If you are interested in a death cover that's just big enough, HDFC SL ProGrowth Super II is something worth a try. The beauty is it has something for everybody — you name the risk profile, the category is right up there. But do a SWOT analysis of the basket, and the gloss fades     HDFC SL ProGrowth Super II is a type-II unit-linked insurance plan ( ULIP ). Launched in September 2010, this is a small ticket-size scheme with multiple rider options and adequate death cover. It offers five investment options (funds) — one in each category of large-cap equity, mid-cap equity, balanced, debt and money market fund. COST STRUCTURE: ProGrowth Super II is reasonably priced, with the premium allocation charge lower than most others in the category. However, the scheme's mortality charge is almost 60% that of LIC mortality table for those investing early in life. This charge reduces with age. BENEFITS: Investors can choose a sum assured between 10-40 times the annualised premium...

Section 80CCD

Top SIP Funds Online   Income tax deduction under section 80CCD Under Income Tax, TaxPayers have the benefit of claiming several deductions. Out of the deduction avenues, Section 80CCD provides t axpayer deductions against investments made in specific sector s. Under Section 80CCD, an assessee is eligible to claim deductions against the contributions made to the National Pension Scheme or Atal Pension Yojana. Contributions made by an employer to National Pension Scheme are also eligible for deductions under the provisions of Section 80 CCD. In this article, we will take a look at the primary features of this section, the terms and conditions for claiming deductions, the eligibility to claim such deductions, and some of the commonly asked questions in this regard. There are two parts of Section 80CCD. Subsection 1 of this section refers to tax deductions for all assesses who are central government or state government employees, or self-employed or employed by any other employers. In...

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...

What is Electronic Clearing Service (ECS)?

  As the name suggests, it's an electronic process through which money can be transferred from one bank account to another. According to RBI, this mode is usually used for regular payments and receipts, like distribution of dividend, interest, salary, pension etc. This mode is also used for collection of bills for telephone, electricity, water, various types of taxes, payment of EMIs , investments in mutual funds , payment of insurance premium etc. There are two types of ECS , like most other banking transactions, ECS credit and ECS debit. An ECS credit is used by a bank account holder , usually a large company or an institution for services like payment of dividend, in terest, salary, pension etc. If your mutual fund pays you dividend to your bank account, of all probability it is being paid through ECS credit.ECS debit, on the other hand, is used when a company or an institution is getting money from a large number of people. For example if you are investing in a mutual fund sc...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now